MorningWord 3/14/16: VW Bugs

by Dan March 14, 2016 9:48 am • Commentary

QE induced V & W bottoms in the U.S. stock market have been a hallmark of the bull market rally since the financial crisis.  You know the drill, stocks lagged without the tailwind between bouts of QE then picked up steam once the medicine was back in the bloodstream.  The chart below shows the S&P 500’s (SPX) performance in between the Fed’s bond buying in 2011 and 2012 that yield the two largest peak to trough sell-offs since the financial crisis, until very recently:


In 2014 the Fed actually started to Taper monthly bond buying with the intent to wind down QE with the ultimate goal of ending the Zero Interest Rate policy that had been in place since 2008. The SPX’s V bottom following its 10% decline in October 2014 (that coincided with the end of QE) had a very similar feel to prior bouts of downward volatility that were met with dovish Fed Action & Speak, with the index making a new high within a matter of months.

The makeup of the declines changed dramatically in 2015, with V bottoms turning into W bottoms, implying that the snap backs off of the initial low was rejected with a test of the prior low.  But like the prior Vs, the August / September 2015 W, and the one we are in the midst of now have a very different feel, can you see what it is?

SPX 8 year chart from Bloomberg
SPX 8 year chart from Bloomberg

After years of the SPX not making a lower low during its 200 plus percent rally off of its 2009 lows, it finally did so in November, and a failure below 2116 (the Nov 2015 high and still some 96 points or 5% higher than current levels) would still mean that the SPX is in a downtrend. This combination of the lower highs, and lowers lows, and three 10% or more selloffs since the end of QE and ZIRP is new and not bullish in my opinion.  I would not change my intermediate term cautious view on U.S. Stocks until the market put in a close above 2100:

from Blooomberg
from Blooomberg

As far as the fundamentals behind the charts, despite the SPX being just a few percent from its all time highs, per FactSet:

“the index reports a decline in earnings for Q1, it will mark the first time the index has seen four consecutive quarters of year-over-year declines in earnings since Q4 2008 through Q3 2009”

And the profit picture does not appear to be improving in the near term, per FactSet:

117 companies in the index have issued EPS guidance for Q1 2016. Of these 117 companies, 91 have issued negative EPS guidance and 26 have issued positive EPS guidance. Thus, the percentage of companies issuing negative EPS guidance to date for the first quarter is 78% (91 out of 117). This percentage is above the 5-year average of 73%

Yet SPX companies are buying their stock back hand over fist, per Bloomberg:

constituents are poised to repurchase as much as $165 billion of stock this quarter, approaching a record reached in 2007


S&P 500 companies have churned out more than $2 trillion of repurchases since 2009, helping sustain a rally where share prices almost tripled. Bolstering the outlook for debt-financed buybacks

And the problem here is when you link the profit outlook, with potential for rising cost of debt to finance buybacks, there reaches a spot of diminishing returns. And in many cases those diminishing returns turn into absolute capital destruction. Companies like Caterpillar and Walmart have seen billions in cash they spent on their own shares go up in smoke over the last year. Meanwhile, both companies are firing workers.

It feels like the only hope for new highs in the SPX in 2016 is to finally get the mom and pop investor back in. Many have been on the sidelines or have been turned around a bit in the last 6 months, selling at W bottoms and buying tops. And with the Fed going the other way from what has kept volatility low for so long, it may be a difficult task to get those investors excited again.